The tax-smart ways to pass on a business to the next generation

THE PASSING OF business assets and wealth to the next generation is an area that requires comprehensive tax planning if future liabilities are to be minimised.

Despite this, the majority of Irish businesses have no succession plans in place. Here we look at the tax liabilities that arise on the transfer of business assets and also some ways that those tax bills can be reduced.

The two main taxes that need to be addressed when transferring assets are Capital Gains Tax (CGT) at 33% for the ‘giver’ of the assets and Capital Acquisitions Tax (CAT), more commonly known as inheritance tax, at 33% for the ‘receiver’.

There may also be stamp duty of 1% or 2% of the value of the assets being transferred, and VAT considerations should always be taken into account.

Here are some useful tips:

Capital Gains Tax

Plan the transfer of your business to your family once you reach 55 years of age and avail of ‘retirement relief’ from CGT.

Retirement relief can provide for a total exemption from CGT, and claiming the relief does not require the business owner to retire or relinquish control of the business.

Broadly, once the business owner is aged 55 years or older and a number of conditions are met, the business may pass to the owner’s children free of CGT.

Once the business owner reaches the age of 66 years, however, the value of the business that can be transferred from CGT is limited to €3 million.

This means that, from a tax perspective, it may be more beneficial to transfer a business sooner rather than later, and early planning is a must to ensure that all relevant conditions for the relief are met at the right time.

There is another CGT relief, ‘entrepreneur relief’, which reduces the rate of tax that applies to the gift of a business to 10% – rather than the standard 33% rate.

When conditions are met, the reduced tax rate applies to gains on the transfer of business assets with a value of up to €1 million during the business owner’s lifetime. As such, this tax relief may be worth €230,000 for some business owners.

Where your business is run through a company, and it has sufficient retained reserves, that company may acquire your shares.

Generally, when a trading company acquires an individual’s shares, that shareholder is liable to income tax, USC and PRSI at the marginal rate on the sales proceeds – a tax rate of approximately 52%.

A relief known as ‘company buyback of shares relief’ exists to treat the acquisition of your shares by your company using CGT (33%) rather than income tax (52%). However, there are very strict conditions that must be satisfied in order for this relief to be available.

Capital Acquisitions Tax

The relationship between the person giving the assets and the person receiving the assets is central to assessing the CAT liability arising on the transfer.

Depending on the relationship, a certain value of benefit may pass from the giver to a beneficiary before any liability to CAT will arise. Where the beneficiary is a child of the giver, the exempt threshold is €310,000.

If a parent is looking to transfer business assets to more than one child, it can be very tax-efficient to split the assets in such a way as to best utilise the tax-free threshold for each child.

Of course, commercial and other considerations can mean that this is not possible.

If the gift or inheritance consists of qualifying business trading assets – including certain shares in family companies – the market value of the business assets can be reduced by 90% if the necessary conditions are met.

If the gift or inheritance consists of agricultural property, like farm land, buildings or machinery, the market value of the gift or inheritance may be reduced by 90% if certain conditions are met.

This is a valuable relief which in certain circumstances can provide for the transfer of farming assets between generations without incurring a large CAT bill.

When a ‘blood’ nephew or niece works in a family business and the owner of the family business wishes to transfer the company’s assets to their niece or nephew, then where certain conditions are met the value of what they may receive CAT-free is increased from €32,500 to €310,000.

Gifts of assets from parents to children will often give rise to a CGT liability for the parent and a simultaneous gift tax liability for the child. Usually, the CGT paid by the parent can be credited against the child’s gift tax liability.

The property transferred must be held by the child for a period of two years or the relief is clawed back.

Tax-efficient business structures

Frequently, an individual may want to pass on the ownership of business assets tax-effectively to children but also want to maintain control over these assets until the timing is appropriate.

Here are two options:

Family partnership structure

The family partnership structure enables parents to exercise a degree of control over the business assets that they wish to share with their children during their lifetime.

This mechanism allows parents to transfer assets to their children at today’s value and pay tax at today’s rates while still retaining control of the assets. Any increase in the value of the assets is attributable to the partners, including the children.

Share freezes

The benefits of share freezing are that is freezes assets of the company at today’s value. The current shareholders retain control until they wish to exit the business while at the same time saving on future inheritance tax for the ultimate recipients of the shares.

This article is general in nature and does not purport to offer professional advice.

Mairead Hennessy is the principal at Taxkey.ie.

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